Securities Analysis
This topic is calculation-heavy: the exam gives you numbers and asks for a ratio, a valuation or a technical reading. The two schools are fundamental analysis, which estimates intrinsic value from financial data, and technical analysis, which studies price and volume; bond analysis (yields and duration) rounds out the set. Learn each formula and practise plugging in.
Fundamental analysis and its goal
Fundamental analysis estimates a security's intrinsic value from the economy, the industry and the company's financial statements, then compares that value with the market price to judge whether the security is cheap or dear. A top-down approach starts with the macro economy and narrows to sectors and then stocks; a bottom-up approach starts with the individual company. The output feeds the two families of tools that follow: valuation multiples that compare price to a fundamental (earnings, book value, dividends), and quality metrics that assess profitability, liquidity and leverage. The exam mostly tests the mechanics, so the priority is knowing exactly what each ratio divides by what, and what a high or low reading implies.
Valuation multiples
The price-to-earnings (P/E) ratio is share price divided by earnings per share (EPS) and shows how much investors pay per unit of earnings: a HK$40 share with HK$2.50 EPS has a P/E of 16. EPS itself is attributable profit divided by shares in issue: HK$200 million over 50 million shares gives HK$4.00. A high P/E generally reflects high expected growth (or an expensive market). The earnings yield is the inverse of the P/E, so a P/E of 16 implies an earnings yield of about 1/16 = 6.25%. The price-to-book (P/B) ratio is price divided by net asset (book) value per share: HK$24 over HK$8 book value gives 3.0, where book value per share is shareholders' equity divided by shares (HK$1,000 million over 200 million shares = HK$5). Dividend yield is annual dividend divided by price; if the price falls while the dividend is held, the yield rises. The PEG ratio divides the P/E by the expected earnings growth rate (a P/E of 20 with 10% growth gives 2.0), and a PEG well below 1 is often read as cheap relative to growth. Enterprise value (EV) is market capitalisation plus debt minus cash: HK$800m + HK$200m - HK$50m = HK$950m.
Profitability, liquidity and leverage ratios
Profitability: return on equity (ROE) is net income divided by shareholders' equity (HK$120m over HK$800m = 15%); return on assets (ROA) is net income over total assets (HK$90m over HK$1,500m = 6%); gross margin is gross profit over revenue (HK$300m over HK$1,000m = 30%); net margin is net profit over revenue (HK$80m over HK$1,000m = 8%). The DuPont analysis decomposes ROE into net profit margin, asset turnover and financial leverage (the equity multiplier). Liquidity: the current ratio is current assets over current liabilities (HK$600m over HK$300m = 2.0); the quick (acid-test) ratio strips out inventory ((HK$600m - HK$200m) over HK$250m = 1.6); working capital is current assets minus current liabilities. Leverage and cover: the debt-to-equity ratio is total debt over equity (HK$600m over HK$400m = 1.5); interest cover is EBIT over interest expense (HK$500m over HK$100m = 5 times); the dividend payout ratio is dividend per share over EPS (HK$1.20 over HK$3.00 = 40%) and dividend cover is its inverse (EPS over DPS = 2.5 times).
Intrinsic-value models
Two discounting models appear. The dividend discount (Gordon growth) model values a share as next year's dividend divided by (required return minus growth rate): a HK$2 dividend with a 10% required return and 5% growth is worth 2/(0.10 - 0.05) = HK$40; a HK$3 dividend with a 12% required return and 6% growth is worth 3/(0.12 - 0.06) = HK$50. A discounted cash flow (DCF) valuation estimates value as the present value of all expected future cash flows; in a multi-stage DCF the terminal value captures the value of cash flows beyond the explicit forecast period. Two sensitivities are tested: raising the discount rate lowers the valuation (future cash flows are worth less today), and the required rate of return rises with higher risk-free rates, higher risk or higher inflation. These models make concrete the time-value ideas from the overview topic.
Technical analysis
Technical analysis studies past price and volume, not financial statements, on the assumption that prices move in trends and history tends to repeat, so patterns can anticipate movements. A simple moving average (SMA) smooths noise: the 5-day SMA of closes 20, 22, 24, 26, 28 is their sum divided by five, HK$24; the 3-day SMA of 16, 18, 20 is HK$18. A moving average is a lagging indicator because it is built from past prices. A 'golden cross' (a shorter average crossing above a longer one) is bullish; a 'death cross' (shorter crossing below longer) is bearish. Support is a price level where buying tends to halt a fall; resistance is a level where selling tends to cap a rise, and a decisive move above resistance on strong volume is a 'breakout'. An uptrend is a series of higher highs and higher lows. The Relative Strength Index (RSI) above 70 signals overbought, below 30 oversold. A head-and-shoulders top is a classic reversal (bearish) pattern, and volume is used to confirm the strength of a move.
Bond yield and duration analysis
Bond analysis extends the yield ideas from the securities topic into measured risk. Current yield is annual coupon divided by price: a HK$5 coupon at HK$80 yields 6.25%, at HK$120 yields about 4.17%, and a HK$4 coupon at HK$50 yields 8%. Yield to maturity (YTM) is the discount rate equating price to all future cash flows, so a discount bond has YTM above coupon, a premium bond below, and a par bond has coupon = current yield = YTM. Price and yield move inversely. Duration measures a bond's price sensitivity to interest-rate changes (and, in the Macaulay sense, the weighted-average time to receive cash flows): longer maturity and lower coupon both raise duration, so a long-dated, low-coupon bond is most rate-sensitive and the duration of a 10-year zero-coupon bond is approximately 10 years. Modified duration converts this into an estimated price move: a bond with modified duration of 6 falls about 6% if yields rise by 1% (100 basis points). Interest-rate risk is therefore greatest for long-duration bonds, which is exactly what the exam wants you to spot.
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In the HKSI LE Paper 8 (Securities) guide: 12 worked calculations set inside the 6 chapters, where the maths comes up. Practice here stays free.